Stay braced for high intra-day volatility and a settlement where the market could move between 2,900-4,000.
Despite truncation due to voting in Mumbai, the April settlement saw a very high carryover into May. Near-month option premiums are liable to drop sharply when the market reopens on Monday.
Slowing momentum and high intra-day volatility marked the last phase of a settlement unusual in many ways. April saw massive increases in trading volumes along with continuous price rise. But profit-booking in the last three sessions may lead into a sideways trend.
The “ultra-long weekend” could cause distortions and exaggerated movements when the market reopens. Normally, settlement on Thursday is followed by one session of the new settlement on Friday when option premiums settle down. This time, the truncation means May premiums closed unrealistically high.
There will undoubtedly be a sharp correction downwards with respect to premiums on Monday. There could also be a major shift in underlying prices with the market opening with a big gap in either direction. A four-day market holiday always creates potential for extra volatility, especially when elections are thrown in.
Although FIIs have remained net buyers who poured over Rs 7,000 crore into equities in April, domestic institutions have been heavy net sellers in the past fortnight. If the nervousness of domestic institutions infects foreigners, the bull run could terminate. As of now, the FIIs continue to hold around 37 per cent of all open interest.
There’s been a narrowing of the market, which is sometimes noticed before a change in trend. The Midcaps and BSE 500 offered negative returns over the last fortnight (the data is more reliable over a fortnight than the last week with only three sessions). This narrowing could translate into higher hedge ratios as the trader-focus on the Nifty becomes more pronounced.
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The CNXIT sustained the market last week when it produced strong positive returns on the back of a rupee that dropped below 50. But if the rupee recovers, the IT sector is likely to start underperfoming. It is not a reliable driver of the market due to that.
The BankNifty saw little net movement though many bank stocks displayed very high intra-day volatility. Financial stocks are the likeliest drivers of the market direction, because they have high weight in the Nifty and Junior and it’s a high-beta sector. If there’s a clear trend in banking, it would drive the Nifty.
Last week, the BankNifty and Nifty movements were very similar, - both featured low net movement and high intra-day volatility. If this pattern holds, the market could swing through several 120-150 point sessions without establishing a clear trend. Indeed, this is what it did last week when it moved between 3,350-3,517. However, if it does close above 3,500 or below 3,350, it will probably establish direction. A correction seems more on the cards than a further upmove.
A breakout in either direction is almost certain in May, given that the Nifty is very rarely stuck inside a 3-5 per cent range for appreciable lengths of time. Any breakout would set up a minimum target of 200 points. Given the elections, a 400 point move is more likely as and when a breakout does occur.
Traders will need to stay braced for both high intra-day volatility and a settlement where the market could move between 2,900-4,000. In general, this requires the liberal use of index options rather than futures because options are easier to hedge. In particular, working out strategies is difficult until we have realistic premiums across the option chain. Although the current risk-reward ratios of various option spreads appear reasonable, this could change as premiums drop across the chain.
As of now, the May Nifty put-call ratio (PCR) in terms of open interest ratio is down to around 1.1 which is nominally bullish but close to overbought. The PCR is unreliable until we have at least one clear session of the new settlement. But it could be signalling a vulnerability in the short term.
A standard bullspread of long 3,500c (160) and short 3,600c (114) offers a maximum return of 54 on a maximum cost of 46. A standard bearspread of long 3,400p (133) and short 3,300p (99) offers a maximum return of 66 on a cost of 34. We don’t know how much these risk-reward ratios would change on Monday. Risk-reward ratios further from the money are similar. Bearspreads are offering higher payoffs across the entire chain.
A long-short strangle combination such as long 3,700c (77) and long 3,200p (71) could be capped out by a short 2,900p (25) and a short 4,000c (18). The net cost would be 105 and the maximum pay off would be around 195 with breakevens at 3,095 and 3,805. This is excessively expensive though the risk-reward ratio is good. If close-to-money premiums drop on Monday, re-examine this position.
| STOCK FUTURES/ OPTIONS Most of the active stock underlyings are displaying a pattern of massive volatility, high volume and uncertain direction. The disciplined trader might choose to forget about them until the market trend is clearly defined. If you take naked stock futures positions, keep tight stop-losses. Otherwise setting up hedges against stock futures will require determination of beta followed by Nifty option positions in the opposite direction. |
If you do wish to dabble in stock futures, one possibility is to short either Tata Steel or Sesa Goa since metals appear to be falling globally. Another possibility is to go long in something like Welspun Gujarat, which may currently have a bullish profile independent of the market.